Morgan Shapes Up

A fter a humbling finale to 1997,
J.P. Morgan
finally got tough. In late February, just a month after the bank reported a 35% drop in fourth-quarter profits, management laid off 5% of its work force, and Chairman Douglas A. "Sandy" Warner warned the rest that it was now or never if Morgan were to complete the final leg of its journey from old-line bank to big-shot brokerage and trading powerhouse.

The troops seem to have heard the word, judging from Morgan's sunny second-quarter earnings report, issued Tuesday. Powered by robust revenue gains in investment banking and trading, the company earned $402 million, or $1.96 a share, from operations, compared with $374 million, or $1.85, the prior year. Including a one-time after-tax gain of $79 million from an asset sale, net income for the second quarter reached $481 million. Revenues rose 20%, to $2.15 billion, with proprietary activities accounting for less than 10%.

Although net interest revenues in the quarter fell 41% to $290 million, the rest of the news was surprisingly good. For openers, Morgan seems to be getting a grip on its runaway expenses, which rose 14% from the level in the prior year's second quarter but remained flat with March-quarter expenses.

Trading revenues jumped 83% to $877 million and investment banking revenues grew 23% to $362 million. Despite the enormous expense of building an equities business from scratch ("J.P.'s Heir," June 2, 1997), Morgan to date hasn't cracked the top tier of Wall Street underwriters. But the firm is making progress -- in this year's first half, it ranked ninth in U.S. equity lead underwriting and fifth in completed mergers and acquisitions worldwide. Although Morgan frequently pops up as a buyer-and-seller on Wall Street's rumor circuit, the company still seems to relish going it alone.

Morgan's investment management revenues grew 8% in the quarter to $277 million, while assets under management approximated $300 billion. Although the firm continues to expand overseas, it sees a potential mother lode in high-net-worth clients on these shores. Says John A. Mayer, Morgan's chief financial officer, "Twenty million people in the U.S. have investable assets north of $1 million, and no one firm has a measurable market share."

Morgan had stubbed its toe in Asia in last year's fourth quarter, ultimately designating $587 million of assets, chiefly swaps with Southeast Asian clients, as non-performers. In this year's second quarter the company charged off $83 million, related primarily to counterparties in South Korea and Indonesia, but the firm managed to cut its exposure to Southeast Asia by 26% to $3.4 billion.

Morgan also has made progress on an even more significant front. With a nod from the Federal Reserve, the firm has been able to lower the capital requirements of its credit business, thereby lifting return on equity to 17.3% -- the highest in more than a year.

J.P. Morgan's shares, like the company's fortunes, have had some wild swings in the past 12 months. A smart trader could have made 52% by buying the stock in late January around 99 and selling it on April 15 at 148 11/16. On a 12-month basis, however, the shares are up just 20%, to 130, sorely lagging the rest of their banking brethren.

Yet therein lies much of Morgan's appeal, at least to Judah Kraushaar, Merrill Lynch's banking pro. "This is a neglected stock," he says. "Morgan trades at two times book value, while more traditional broker-dealers trade at almost twice that level."

-Lauren R. Rublin

Down and Out

Hancock axes former star after performance flags

F or five years, starting in 1991, Michael DiCarlo churned out spectacular returns for the
John Hancock Special Equities
fund. Focusing on companies whose earnings were growing at least 25% a year and with market caps below $750 million, DiCarlo clobbered the S&P 500 year after year. Highlights included returns of 84.5% in 1991 and 50.4% in '95. (They certainly attracted Barron's attention -- we published Q&As with DiCarlo in both 1993 and 1996.) Emboldened by his glittery record, DiCarlo left John Hancock in 1996, and with two partners set up his own Boston-based money-management firm, DFS Advisers. The parting was amicable; DiCarlo agreed to keep running the fund for five years, and Hancock took a minority stake in his new firm.

And that's where Special Equities' glorious run came to an abrupt end. In 1996, the fund returned just 4%, followed by a similarly uninspiring 5% in '97. The lackluster performance continued in the first half of this year. Through June 30, Special Equities Class A shares gained just 2.1%. Assets in the fund, which stood at nearly $2.2 billion in May 1996, slumped to $1.4 billion. Clearly, Hancock had seen enough. On July 1, DiCarlo got the boot, replaced by Laura Allen, a 17-year veteran of Wellington Management, who had joined Hancock in April.

Ann Hodsdon, president of John Hancock Advisers, says the decision to end DiCarlo's relationship with the fund was mutual. However, the firm makes no bones about it: DiCarlo got the axe for weak results. "I have relatives who are in the fund, and I get beat up by them," Edward Bourdeau, chief executive of John Hancock Funds, told the Boston Globe recently. "The performance was disappointing."

DiCarlo contends that the weak stretch mainly reflected underperformance by small-cap growth issues in general, rather than bad stock selection. Hancock officials see things differently; while they saw nothing wrong with his investment style, they think he picked the wrong stocks.

Allen declines for the moment to talk about how she might shift around the portfolio DiCarlo built, although she does say the fund will stick closely to fast-growing stocks with market values under $1 billion. One thing likely to disappear will be the fund's position in
America Online
, which at March 31 ranked as the second-largest holding, at 3.9% of assets. Although its stock price has soared in the past year, AOL misses the $1 billion cutoff by, oh, $20 billion or so.

Meanwhile, DiCarlo still has plenty of ideas for stocks to buy -- he mentions, for instance, Nasdaq market-maker Knight Securities and the World Wide Web-based music retailer
CDNow
. And he still has an outlet for his picks -- DFS Advisers continues to manage $70 million in two hedge funds. Says DiCarlo: "For the time being, we have enough on our plate."

But that, in fact, is what happened to Lincare, whose stock dropped 12%, to 37 3/8, on Monday, and stayed shaky thereafter. The dive began after the oxygen and respiratory-therapy provider disclosed that federal investigators had subpoenaed documents related to oxygen services provided to Medicare and other patients at Lincare facilities in California and Oregon in 1995 and 1996.

Lincare officials say they don't know what the feds are seeking, but that the company isn't guilty of any wrongdoing and may not be the actual target of the investigation.

The disclosure came soon after similar subpoenas were served on
Apria Healthcare
, another home-health-care provider.

Armstrong, the top-ranking manager of the $660 million
MAS Mid-Cap Growth
fund, remains a fan of Lincare, which has faced some challenges before, although none of this particular type, she notes, without jeopardizing its financial condition.

Though earnings for 1998 will be slightly lower than 1997's, she thinks Lincare will grow rapidly. The fund manager dismisses last week's news, which she says is unlikely to affect earnings. "This seems to me like a situation that will probably blow over," she adds. And what does the near future hold? On July 21, Lincare is expected to report earnings of 32 cents a share for the second quarter, versus 39 cents a year earlier. Last week's stock-price drop, Armstrong contends, has created "a buying opportunity."

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